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The Current European Challenge: The View from Prague

English Pages, 22. 9. 1999

It is a great pleasure to be here, to visit again this beautiful city and to be able to address this distinguished audience.

The coming end of the century is a suitable moment for reflections, for looking back, for thinking about the future. I would like to talk today about two topics. The first one will be the transition in Central and Eastern Europe and the second one the current phase of European integration. Those are – in my understanding – the main current European challenges. I know it is difficult to say anything new to both topics. I will try, therefore, to make my position very clear and straightforward.

The Problems of Transition

The decade of the nineties started with many hopes connected with the collapse of communism. I always stress that communism was not defeated. It – sort of – melted down. The long-time awaited event created enormous expectations on all sides – for insiders and outsiders – and as a result of it, the e-r gap, the expectations-reality gap – in spite of many undeniable positive achievements in most of transition countries during the last decade – has been growing which led to a serious loss of confidence both of transformation results and transformation strategies. Dramatic controversy about both of them continues and will be with us for some time to come.

It seems to me that now almost everyone forgot the evils and irrationalities of communism and is surprised that its dismantling is not fast and smooth enough and that it takes non-zero time and non-zero costs to replace it with a full-fledged market economy.

There is a problem with the current debate about transition. The debate about transition economies (and emerging markets) has been dominated by a very powerful rent-seeking group of advisors and consultants, of investment bankers, of powerful auditors and of bureaucrats of international financial organizations who have a vested interest to prolong transition as much as possible, and not to let transition countries to do it alone (which means without them). My refusal to unconditionally surrender to their views and my statement “I am not ready to pay hard money for soft advice” (which Milton Friedman dubbed “Klaus’s law”) made me many enemies in this privileged group.

I expressed my views about transition (and described my experience with it) in many speeches and articles and it is probably too early to add anything substantial to my original “Ten Commandments of Transition”. I will make today only several short remarks:

to paraphrase the well-known saying (ascribed to Milton Friedman) I can say that “there is no such thing as a free reform”. The change of the whole political, economic and social system is very costly. The transformation costs consist of the loss of output (and income), of the fundamental redistribution of gains and losses in society, of the increase of inequality in income and wealth, etc. The costs have to be paid by citizens of the transforming countries themselves (with the exception of the former East Germany) and the contribution of the rest of the world is marginal (if any and if not a negative one);

the reforms usually started with emphasis on liberalization, deregulation and privatization. The implementation of these reform measures changed the system, but was not able to do more than to create weak and shallow markets and imperfect market infrastructure. It could not have been different. The inefficient (or not fully efficient) markets and markets-accompanying institutions magnified transformation costs and together with them, the unpleasant feelings of less successful participants of the transition process. The reformers have been heavily criticized for the fact that they “created” only weak markets and imperfect institutions, but the markets have to evolve, they cannot be “created”, and especially not by law, decree or regulation. In addition to the problem of evolution our distrust of the state and its potential positive, constructive contribution was much stronger in our part of the world than in yours. In the past, we suffered more from the “government failure” than you and we believed that the market failure is much smaller and less dangerous than the failure of government;

we understood very soon the fallacy of the artificially introduced dilemma called “shock therapy vs. gradualism” which used to be so popular 10 years ago. The systemic change is a sequence of many distinct choices over time on separate components of an overall reform plan and not a single decision. It takes a whole historic period. It is not an exercise in applied economics. It is not done in a laboratory or in a vacuum. It is done by means of a very complicated political process in an open, democratic and pluralistic society (there is no masterminding of it). Many reforms failed or had very high costs because of their partiality and because of the time-inconsistency problem connected with the fact that the individual reform measures have different time dimensions. This is, however, an unavoidable fact of life.

What are the main future dangers?

The country in the moment of transition does not make marginal changes (as a non-transition country). It makes substantial changes. There has not been a long, gradual, spontaneous evolution of institutions, rules or networks of relations based on the enormous variety of human interests, hopes, dreams and ambitions. Because of that, we still live in a “pre-emptied” system which does not have the friendly, softening mechanisms of intermediation between invisible hand of the market and visible hand of the government. Such an intermediate structure cannot be imposed upon society from above, it has to evolve. There are, however, many attempts not to let it freely evolve. In our society, the strong and noisy pressure groups often succeed in using legislation for gaining power and privileges at the expense of both individual citizens and the whole community and for shifting society from traditional liberal democracy to neocorporativism. It has an important connection to the currently fashionable idea of communitarism (or civic society as it is called in some countries). Communitarism is less dangerous in a mature, sufficiently diversified society but it may very easily refeudalize society in an immature - and in this respect shallow - society.

Second future problem is connected with the existing fragility and vulnerability of transition economies and with the growing requirements of a globalized economic environment. The transition countries have several particular and very unpleasant characteristics. The relevant ones in this respect are higher inflation and to current account deficits which are not compatible with fixed (and stable) exchange rates. Transition economies have, at the same time, investment-savings imbalances and because of that, they need foreign capital to ensure some sort of equilibrium. Foreign capital wants fixed exchange rates and easy outflow´s possibilities. All of that does not simultaneously exist even with the best domestic policy.

The reconciliation of all those variables cannot be arranged and permanently guaranteed ex-ante. It is sometimes enforced upon the economy ex-post, as a result of economic, financial and currency instability (or crisis). This creates, however, a politically and socially very complicated situation and, as a result of it, the political support for the continuation of transformation is heavily undermined. This is what we have seen in recent years, and paradoxically more in relatively more successful transition economies.

The Problems of the European integration process

Europe is currently – at least nominally – preoccupied with two parallel processes: one of them is the deepening of the European integration process, the movement towards European unification and the other is the widening, the expansion of European Union to the East. I deliberately said “nominally” because, as I understand it, both processes do not represent true and genuine interests, dreams and ambitions of the European (and Spanish and Catalonian) citizens. They are – both of them – advocated by several specific groups of European society only and are in the interest of one very influential rent-seeking group, the group of European bureaucrats, who are and will be net beneficiaries of both processes. In Europe there is no other “concentrated” group which could play the countervailing role. With uninvolved and indifferent majority of Europeans, who live in a nirvana of unconsciousness of what is going on and who maximize all pleasures coming from a relatively easy life of mature, rich and in many dimensions “unconstrained” society which is unaware of its limits (and of its strong rivals and competitors), a small minority can have a decisive power.

The same decisive minority has no genuine interest in the only European project which is worth of being done – in redefining Europe along classical liberal ideas, in rejecting new Third Ways, in dismantling “soziale Marktwirtschaft” (social market economy), in breaking down paternalism and corporativism flourishing these days in Western Europe more than in any other part of the world.

I would like to add a few words about the European Monetary Union, but I have to admit that I am a very special person to talk about monetary unions, because I am well-known for participation in the dismantling monetary union called Czechoslovakia. It gives me, however, a very special perspective and a special sensitivity to this topic.

As a politician and a former economist, I have a frustrating feeling that everything about EMU has already been said, that there is nothing to add, and that there is no lack of knowledge. The problem is whether we use the existing knowledge or not. Famous economists repeatedly tried to explain basic, more or less textbook arguments about both optimum currency areas and monetary unions, but I am afraid the architects of EMU didn’t listen carefully or sufficiently.

Well-known economists continue to remind us that the conditions for a successful monetary union are microeconomic, which means that they have directly nothing to do with the macroeconomic conditions specified at Maastricht. It has been repeatedly emphasised as well that the benefits of free-trade are connected with a free-trade area and a customs union, and not with a monetary union. It has been argued that the appeal of getting something for nothing is wrong, that it is not possible to convert a variable into a constant without paying an inevitable price, without provoking movements of some other variable or variables.

I could go on with similar arguments, but it seems to me that it does not help because it became normal to talk about the benefits of a monetary union and not about its costs.

There will be costs and not just benefits. I will discuss here one issue only. It seems to me that the architects of the Euro must be – to use labels well-known in the economic profession – new classicals or at least elasticity optimists. They have to assume that prices and wages in Europe are so flexible that exchange rate adjustment is not, and will never be, needed. Additionally, they have to assume that labour mobility is very high.

The empirical data do not support these assumptions. In such a situation, something else must become flexible. We call this variable fiscal transfers but their potential size and frequency have not been seriously discussed. (All of us know that the size of fiscal transfers in a recently created monetary union called Germany was and still is enormous. I am aware of the size and frequency of fiscal transfers in a monetary union which used to be called Czechoslovakia. I was its last Minister of Finance who was responsible for sending fiscal transfers from one part of the union to another and I know that it was impossible to continue.)

When introducing EURO, it was - probably implicitly or subconsciously - assumed that currency domain (monetary union) can be greater than fiscal domain (fiscal union). As far as I know, it has never been proved, however, that this can be a viable institutional arrangement. I am convinced of the inevitability of the following path: monetary union à fiscal union à political union. One of the consequences of EMU, and I include it on the side of costs, will be therefore the emergence of a fiscal and political union. And the justified question is: Do we really want a political union? I would strongly argue that we shouldn’t feel being guilty of a dreadful sin when we raise such a question or even give a qualified answer to it.

The existence of a monetary union without political union means that countries delegate monetary policy to a supranational agency. It can be neutral only on condition that there is a unified economic interest. It is, however, a very problematic assumption when we look at the current European heterogeneity. I’m afraid, therefore, that the costs and benefits of European monetary union will not be equally distributed among its members.

This brings me to my last point. The Euro is a very ambitious project – and I agree with those who say that it is the most important change in the international monetary architecture since Bretton Woods in 1944. It is, however, an alternative to something else. I am convinced that Europe doesn’t need unification but a liberal order. The relevant question is whether EMU brings us closer to such a goal or keeps us preoccupied with an alternative endeavour. I can only hope that Europe will concentrate on the second task with the same determination as on the first one.

To conclude, both parts of Europe face an important challenge. I am optimistic because I believe more in human action, in the activity of millions of free European citizens, than in the ambitious designs and projects of social engineers who want to discover new, third ways based on utopian, unrealistic assumption about human behavior and about the functioning of open, democratic and pluralistic society.

Václav Klaus, The text of the speech delivered at a conference for business leaders, Barcelona, September 22, 1999.


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